by Bill O’Grady and Thomas Wash
[Posted: 9:30 AM EDT] Happy Flag Day! Tensions remain high with Iran and protests continue in Hong Kong. Here is what we are watching today:
Pompeo blames Iran: Yesterday, we reported that two tankers were attacked in the Gulf of Oman. SoS Pompeo has assigned blame to Iran. Pompeo suggested the attack was delivered by divers attaching limpet mines to the tankers. The U.S. Navy provided video giving strong evidence that Islamic Revolutionary Guard Corps (IRGC) commandos were removing previously attached limpet mines. This action by Iran is a significant escalation; the U.S. is taking the matter to the UNSC but, given that Russia and China have veto power, we doubt the U.N. will do anything. We note that Iran continues to dispute the U.S. claim that Tehran is responsible for the attack.
The attack does seem oddly timed. Japan’s PM Abe was in Iran trying to ease tensions; to attack two vessels with cargoes en route to Japan seems to send a belligerent message. One possibility is that rogue elements within the IRGC, wanting to prompt escalation, moved without authorization. If this is the case, we could see reports in the coming weeks of officials in the Corps being demoted or retired. The IRGC’s power has been increasing in recent years and it could be that elements of the group want to challenge the leadership of the clerics. We will be watching for evidence of this theory in the coming weeks.
So, with conditions escalating, why aren’t oil prices soaring? We suspect the next step will be for the U.S. and allies to send military escort vessels to the region as was done in the “tanker war” during the Iran-Iraq War. Although the escorting process is expensive and will slow shipping out of the Gulf, it will prevent escalation (it would be foolhardy for Iran to directly attack U.S. Naval vessels) and keep the waterways open for shipping.
Worries about global demand are also pressuring prices. The IEA cut its forecast for 2019 crude oil demand by 0.1 mbpd to 1.2 mbpd, blaming worsening trade conditions. We note that China’s May industrial production came in weaker than forecast (5.0% vs. 5.4%), and fixed investment eased to 4.3% in May from 5.7% in April on a year-to-date basis. Weakening economic growth in China will obviously dent oil demand and may lead the IEA to make further cuts in demand estimates.
Next week’s WGR looks at the issue of war with Iran.
Hong Kong: Another mass rally is planned for this weekend. We note that Chairman Xi has been touring central Asia during the recent uprising. As he returns to Beijing, we continue to watch to see if China’s calm response to the protests continues. The Chinese leader has a hardline reputation and we can’t see him tolerating this insolence much longer. At the same time, a highly visible crackdown will almost force the Trump administration to react with trade sanctions and could scuttle any chances of a deal at the G-20. Other actions are being considered as well. Therefore, this weekend could be key to the upcoming talks.
China trade news: China announced new anti-dumping measures against U.S. and European steel pipes and tubes. Although China has indicated it wants to move up the tech value chain, it apparently has a serious gap in semiconductors that will severely hamper its desire for tech independence. Six-hundred companies have issued a public letter to the White House asking for the president to resolve the trade dispute with China.
Brexit: Boris Johnson is the front-runner to replace PM May. Although a no-deal Brexit is still being considered, the risks of such an event for the U.K. economy are significant.
Odds and ends: Social media firms have been granted relief from legal liability stemming from posts on their sites. Congress is apparently revisiting this relief and considering if the legal protections should be reduced or removed. If the law is changed, it could open up these firms to legal liability for the content on their platforms. A recent survey suggests that 23% of households believe they are still worse off than they were before the financial crisis. With the expansion nearing record levels, the high number of those still feeling left behind could trigger a strong social reaction in the next downturn if conditions don’t improve further.